The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and looking to gauge the potential return on investment in Stella-Jones Inc (TSE:SJ).
If you purchase a SJ share you are effectively becoming a partner with many other shareholders. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. Your return is tied to SJ’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. Therefore, looking at how efficiently Stella-Jones is able to use capital to create earnings will help us understand your potential return. Investors use many different metrics but the analysis below focuses on return on capital employed (ROCE). Let’s take a look at what it can tell us.
What is Return on Capital Employed (ROCE)?
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if Stella-Jones is good at growing investor capital. I have calculated Stella-Jones’s ROCE for you below:
ROCE Calculation for SJ
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = CA$188m ÷ (CA$2.0b – CA$177m) = 11%
As you can see, SJ earned CA$11 from every CA$100 you invested over the previous twelve months. A good ROCE hurdle you should aim for in your investments is 15%, which SJ has just fallen short of, meaning the company creates an unideal amount of earnings from capital employed.
A deeper look
Although Stella-Jones is in an unfavourable position, you should know that this could change if the company is able to increase earnings on the same capital base or find new efficiencies that require less capital to produce earnings. Therefore, investors need to understand the trend of the inputs in the formula above, so that they can see if there is an opportunity to invest. Looking three years in the past, it is evident that SJ’s ROCE has deteriorated from 15%, indicating the company’s capital returns have declined. Over the same period, EBT went from CA$145m to CA$188m but capital employed has improved by a relatively larger volume because of a rise in total assets , which suggests investor’s ROCE has fallen because the company requires more capital to create earnings despite the previous growth in EBT.
ROCE for SJ investors has fallen in the last few years and is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. However, it is important to know that ROCE does not dictate returns alone, so you need to consider other fundamentals in the business such as future prospects and valuation. If you’re building your portfolio and want to take a deeper look, I’ve added a few links below that will help you further evaluate SJ or move on to other alternatives.
- Future Outlook: What are well-informed industry analysts predicting for SJ’s future growth? Take a look at our free research report of analyst consensus for SJ’s outlook.
- Valuation: What is SJ worth today? Despite the unattractive ROCE, is the outlook correctly factored in to the price? The intrinsic value infographic in our free research report helps visualize whether SJ is currently undervalued by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.